How Does a Non-Compete Clause Work?

In Short

• Non-compete clauses protect your business’s confidential information, IP, and customer relationships from misuse by former employees or partners.
• The clause must be reasonable in terms of geography, time, and scope to be enforceable in Australia.
• Drafting a non-compete clause requires balancing protection with fair competition to ensure it complies with legal standards.

Tips for Businesses

Before including a non-compete clause, assess its necessity and enforceability. Clearly define the restricted activities, timeframes, and geographical areas to ensure it is reasonable. Tailor the clause to protect your confidential information and client relationships, but avoid overly broad restrictions that could be challenged in court.

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Table of Contents

• What is a Non-Compete Clause?
• Using a Non-Compete Clause
• Why Use a Non-Compete Clause?
• Restricted or Competitive Activities
• Enforcing a Non-Compete Clause
• Protecting Legitimate Interests
• Drafting a Non-Compete Clause
• Unreasonable Non-Compete Clauses
• Key Questions to Consider
• Key Takeaways
• Frequently Asked Questions

A non-compete clause, often referred to as a restraint of trade clause, is a common feature in many contracts. You will frequently encounter these clauses in:

• employment agreements;
• sale of business agreements; 
• franchise agreements; and
• contracts where one party has access to sensitive information or intellectual property (IP) belonging to another party. 

In Australia, the legal framework surrounding non-compete clauses continues to evolve. Courts are placing increasing emphasis on balancing business protection with fair market participation. This article explains how non-compete clauses work and what you need to consider 

What is a Non-Compete Clause?

A non-compete clause is designed to prevent a party from using:

• confidential information;
• IP; and
• industry knowledge.

It does not allow the party to compete against the business with which they no longer have a relationship. 

The primary goal is to ensure that a party is not unfairly restricted from competing in the market. Common situations involve an employee leaving their job or a business seeking new opportunities after a sale.

Confidential information that could be protected by a non-compete clause might include:

• financial statements;
• client databases;
• website and traffic statistics; or
• proprietary business processes.

Using a Non-Compete Clause

In your business, you might have employees who handle day-to-day operations and have access to trade secrets, confidential information, and IP. Or you might need to share sensitive information with third parties for your business to run smoothly. 

This clause can help safeguard your business interests by preventing the recipient of this sensitive information from using it to their advantage and engaging in competitive activities.

Some common scenarios where non-compete clauses are used include:

• employment contracts: for example, a senior HR manager may be restricted for six months from taking up similar roles within the same industry’;
• franchise agreements: a café franchisee might be barred from operating another café within a two-kilometre radius of the franchise location;
• sale of business agreements: a seller of an accounting firm could be prohibited from starting a new accounting business for three months post-sale; and
• manufacturing agreements: a food manufacturer might be restricted from producing similar products for competing businesses.

Why Use a Non-Compete Clause?

Including this clause in your contracts could be crucial to your business for several reasons:

1. Protecting Business Interests: One of the key reasons to use a non-compete clause is to safeguard your business’s confidential information and IP. Building a client list, developing marketing strategies, and refining business processes take time and resources. A non-compete clause ensures that a former employee or business partner cannot misuse this information to benefit a competitor. Whilst confidentiality and IP restrictions may prevent this information from being used, a non-compete provides extra protection where non-compliance usage may not be easy to monitor and prevent.
2. Preserving Client Relationships: Your employees often act as the main point of contact with your customers. They gain intimate knowledge of their needs and preferences. When an employee leaves for a competitor, there is a risk that they might attempt to take these loyal clients with them. Non-compete clauses serve as a preventative measure. They make it harder for former employees to leverage these relationships. Similarly, the goodwill in a franchise often belongs to the franchisor and their brand. Therefore, a non-compete allows the franchisor or another franchisee to benefit from that goodwill.
3. Securing Investment in Employee Development: Investing in your employees through training, mentoring, and skill development can be a significant expense. A non-compete clause helps protect this investment. It can discourage employees from using the skills and knowledge gained to benefit a competitor.

Restricted or Competitive Activities

Non-compete clauses typically address three key types of restrictive activities:

1. Non-Compete: may prevent a party from directly competing with your business, such as stopping an ex-employee from joining a rival company.
2. Non-Solicitation: may prohibit a party from soliciting clients, suppliers, or other business contacts they encountered through your business.
3. Recruitment: may prevent the poaching of key personnel, such as senior managers or critical team members, who could be valuable to a competitor.

Enforcing a Non-Compete Clause

Enforcing a non-compete clause requires applying to the relevant Court or tribunal for an order against the restrained person or company. This normally involves obtaining an injunction. To enforce a non-compete clause, a court will consider whether the clause is reasonable and proportionate. The following factors are assessed:

Geographic Area

The region in which the clause applies is critical. For example, restraining someone from working in a whole state or country could be considered unreasonable, while a localised restraint might be more justifiable.

Scope of Activities

The specific activities you seek to restrict must directly relate to your legitimate business interests. Overly broad restrictions are more likely to be struck down by courts.

Timeframe

The duration of the restriction is another key factor. Long restrictions, such as several years, are less likely to be upheld unless they are directly tied to protecting critical business interests.

For instance, a non-compete clause that stops a former marketing employee from working for any Australian media company for three years would likely be deemed unreasonable. Conversely, a clause restricting the employee from soliciting your clients for one year may be considered reasonable and enforceable.

Protecting Legitimate Interests

Your non-compete clause must be tied to a legitimate business interest that is valuable and needs protection. Examples include:

• confidential business information;
• intellectual property;
• trade secrets;
• customer goodwill; and
• business know-how.

Trade secrets, in particular, are vital assets that can give your business a competitive edge. These might include:

• proprietary methods;
• processes;
• formulas; or 
• other confidential information that your business owns and keeps under wraps.

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Drafting a Non-Compete Clause

When drafting this clause, covering more than just individuals is important, as businesses can take various forms. You may need to restrict competitive activities by individuals acting as:

• directors of a company;
• shareholders; or
• trustees of a trust.

A well-drafted clause ensures that individuals in these roles cannot establish or join a competing entity. This effectively safeguards your business from unfair competition.

Unreasonable Non-Compete Clauses

Remembering that an overly restrictive non-compete clause could be deemed against public policy is crucial. Restricting someone from contributing their skills or pursuing future business opportunities could be seen as inhibiting fair market competition. Courts in Australia have the power to sever parts of a non-compete clause they find unreasonable or change them completely, but this differs state-by-state. 

Key Questions to Consider

Before introducing this clause, it is vital to evaluate whether it is both necessary and enforceable. Consider: 

1. What specific activities do you need to restrict?
2. How long should the restriction last? How do you calculate and justify this?
3. Should the restriction apply in a broad or more narrow geographical area?
4. Is the geographic scope reasonable for protecting your interests? What other protections are already in the contract?
5. What specific business interests are you protecting?
6. Does the other party agree that these interests are worth protecting?

Key Takeaways

Non-compete clauses remain a powerful tool for protecting your business’s confidential information, IP, and competitive position. However, they must be carefully crafted to be enforceable. Courts will scrutinise these clauses to ensure they are reasonable and proportionate to the business interests at stake.

If you need help with your business structure, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

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